Notes to Consolidated Financial Statements (Dollars in Thousands) University of Rochester Financial Statements

Transcription

1 Notes to Consolidated Financial Statements (Dollars in Thousands) University of Rochester Financial Statements 1

2 University of Rochester Financial Statements Learn, discover, heal, create and make the world ever better. 2

3 Financial Statement Highlights Overview The University of Rochester ended fiscal year 2012 in a strong financial position with another year of positive operating results driven by the consistent performance of the Strong Memorial (SMH) and Highland Hospitals. However, decreases in discount rates used in actuarially determined long-term benefit obligations had a negative impact on consolidated net assets. For the fiscal year ended June 30, 2012, the University reported a decrease in total net assets of $34 million that comprised a positive increase in net assets from operations of $107 million and a decrease in net assets from non-operating activities of $141 million. Selected Financial Trends (dollars in millions) FY12 FY11 FY10 Consolidated operating revenues $ 2,839 $ 2,753 $ 2,626 Consolidated operating expenses $ 2,732 $ 2,651 $ 2,518 Consolidated investments held for long-term purposes $ 1,823 $ 1,783 $ 1,564 Return on long-term investment pool 1.8% 19.2% 12.1% Consolidated changes in net assets: From operating activities $ 107 $ 102 $ 108 From non-operating activities (141) Total increase / (decrease) to net assets $ (34) $ 302 $ 171 Consolidated total net assets $ 2,650 $ 2,684 $ 2,382 Results of Operations Revenues Total operating revenue increased 3.1% to $2.84 billion and is derived mostly from tuition and fees, grants and contracts, and hospital and faculty practice revenue. These three categories comprise 87.0% of all University revenue sources and are the main financial drivers of the institution. Gross tuition and fee revenue was $361 million representing a 5.0% increase over last year. Approximately 61.0% of all tuition/ fee revenues were generated in Arts, Sciences & Engineering (including the College) and reflective of both rate increases and higher student enrollment. Composite financial aid rates were 42.0% and 41.4% for fiscal years 2012 and 2011, respectively. Total grants and contracts revenue decreased by 9.6% over the prior year to $396 million. Government-sponsored awards account for over 86.0% of all University grants and contracts. The federal government provided $310.3 million, with the Department of Health and Human Services (HHS) accounting for approximately 52.0% of this amount. Federal funding decreased by 7.2% over last year largely attributable to the ending of awards received under the American Recovery and Reinvestment Act (ARRA). New York State funding for capital projects decreased $27.1 million during fiscal year 2012, mainly due to the completion of the Saunders Research Building for clinical and translational science. Aggregate research expenditures were 5.7% behind last year with increases in the Laboratory for Laser Energetics (15.6%), offset by decreases in the University of Rochester Medical Center and Arts, Sciences & Engineering of 11.2% and 3.0%, respectively. Hospital and faculty practice revenue represent about 65.5% of total consolidated revenue sources. The 4.3% increase over last year was generated from the combined clinical operations of the SMH ($1.14 billion), the University of Rochester Medical Faculty Group ($366.1 million), and Highland Hospital ($267.9 million). The main drivers of growth over the prior year were increased volumes at both acute care hospitals and related professionals fees and a new contract pharmacy program which began in fiscal year Gifts and pledges were $50 million higher than last fiscal year and up 81.0%. This year s total included over $20 million for construction of a new tower for the Golisano Children s Hospital at the SMH and $10 million in support of research and related programs of the Saunders Research Building. 3

4 University of Rochester Financial Statements Revenues by Operating Division Revenues by Source 10% 3% 3% 4% 6% 7% 46% 14% 66% 41% University (w/o SMH) Strong Memorial Hospital Highland Hospital All Other Hospital & Patient Care Grants & Contracts Tuition & Fees Gifts & Pledges Endowment Use All Other Expenses EXPENSE by Natural Classification Expense by Functional Classification 6% 7% 2% 4% 12% 3% 20% 65% 15% 66% Compensation Supplies, Business & Professional Utilities, Maintenance & Facilities Costs Depreciation & Interest All Other Hospital & Patient Care Activities Instruction, Library & Student Support Institutional Support Research All Other Operating expenses increased by 3.0% to $2.73 billion for the year ended June 30, Compensation (salaries and fringe benefits expenses), which represents 63.0% of total expenses, was $1.77 billion and increased 5.7% over last year as a result of the 2.5 percent wage and salary program increase and growth in staff of about 2.3%. Fringe benefits increased due to the increase in salaries and wage base and increased costs of health care benefits, including increases in the post-employment accruals (primarily workers compensation). Over 85.0% of total supplies expense is composed of hospital medical/surgical and other consumables. Total supplies expense increased by almost 2.0% due to increased medical/surgical and pharmaceutical supplies at the SMH due to higher patient volume. 4

5 Financial Statements Highlights Major components of business and professional expenses are telecommunications, medical malpractice insurance, royalty payments to faculty inventors, travel, and consulting. The decrease in total business and professional expenses of 2.5% was mainly due to favorable professional liability expenses and lower royalty payouts to faculty inventors. Total utility costs decreased slightly over 3.0% due to reduced natural gas pricing and lower fixed costs resulting from utility distribution repairs made last fiscal year. Other expense decreased $21.8 million due primarily to reclassifying patient bad debt expense reflected in this line item last year that is now netted against the hospital patient care revenue line item as charity care offset. This amounted to $15.2 million and FY 2011 was not reclassified/restated. Related Entities and Affiliates The combined operating activities of the related and affiliate organizations represent about 13.2% of total consolidated operating revenues and approximately 5.3% of total consolidated net assets. Within the affiliated group, Highland Hospital (and subsidiaries) generated operating revenues of $327.4 million followed by Visiting Nurse Service of Rochester and Monroe County, Inc. with $43.1 million. Financial Condition Net Assets Total net assets decreased by $34.2 million or 1.3%. Although the University posted positive operating margins for the year, the major drivers of the decrease in net assets were attributed to significant financial market-driven fluctuations. We experienced declines in the discount rates used in the actuarial valuations of our post-retirement and post-employment obligations, negative mark-to-market adjustments on variable rate debt interest rate swap contracts, and also planned use of endowment for operations coupled with flat investment returns of the long-term investment portfolio. Assets Total assets increased by 4.4% from FY 2011 to $4.51 billion at June 30, The University s cash position (consisting of cash and cash equivalents and operating investments) increased by $40.6 million to $535.2 million and marks the first time we have surpassed a half billion dollars. This increase was the result of better operating margins, improved collections in patient accounts receivable by our hospitals, and reimbursement of prior year capital expenditures primarily from the bond proceeds of Series 2011 issued earlier in FY Accounts receivable increased by $33.6 million. During FY 2012, the University adopted the provisions of Accounting Standard Update (ASU , Presentation of Insurance Claims and Related Insurance Recoveries) that requires all insurance liabilities and recoveries (mainly of our medical malpractice insurance) to be reflected on a gross basis on the face of the financial statements. Approximately $47.7 million has been added to both accounts receivable and accounts payable and accrued expenses on the balance sheet. Contributions receivable increased over 76.0% from the prior year total to $90.9 million. Marking the second year since our public launch of The Meliora Challenge fund-raising campaign, FY 2012 pledge details included over $20 million in support of the construction of the tower at Golisano Children s Hospital and $10 million in support of programs housed in the Saunders Research Building. We were also successful in accomplishing a rather tedious task of reconciling gifts and pledges per the financial statements (recorded under the accounting rules of US GAAP) to the Advancement system (recording gifts under guidelines issued by the Council for Advancement and Support of Education). Long-term investments increased by $39.6 million to $1.82 billion at June 30, The University s long-term investment pool (comprised primarily of the endowment) reported an annual return of positive 1.8% compared to a positive 19.2% last year. Detailed information regarding the University s endowment may be found on the University of Rochester Endowment web page, Additionally, the issuance of bond Series 2011 resulted in net proceeds of $148.8 million. As of June 30, 2012, total unspent bond proceeds were $107.4 million. Property, plant, and equipment increased to $1.56 billion with capital spending of $277.7 million for the year. Included in this year s spending total was $29.5 million for construction of additional space at the Wilmot Cancer Center, $14.2 million for the Raymond LeChase Hall, $12.8 million for the new electronic medical records system, $11.2 million for the O Brien Hall, and $76.7 million for equipment and library acquisitions. Liabilities Total liabilities were approximately $1.86 billion and consistent with levels from last fiscal year. Accounts payable and accrued expenses increased by $82.8 million due primarily to the recording of insurance claims required by ASE ($47.7 million) noted earlier, increases in negative mark-to-market adjustments of interest rate swaps ($12.8 million) and accrued payroll and withholding ($7.1 million). Accrued pension, post-retirement and post-employment obligations increased $78.4 million to $386.5 million as of June 30, The major components included increases in the postretirement/employment obligations ($35.5 million) due primarily to the decline in the discount rates, contributions to and increases in the market values of the University s 457(b) and 457(f) 5

6 University of Rochester Financial Statements retirement plans ($7.5 million), and increases to the defined benefit plan obligations of Highland Hospital and Visiting Nurse Service, Inc. ($35.4 million). Long-term debt increased by $128.3 million to $874.2 million as of June 30, 2012, due to Series 2011 bonds ($148.8 million new money) issued in early FY 2012 through the Monroe County Industrial Development Authority and a $9 million term loan to partially finance the purchase of a new facility (Lac de Ville). Regularly scheduled debt service principal payments resulted in a decrease of $28.6 million. At June 30, 2012, the University s credit ratings are Moody s Aa3, stable outlook, S&P A+, positive outlook and Fitch AA- stable outlook. Summary The University ended the fiscal year with a solid financial performance from operating activities as evidenced by the $107 million increase to net assets. Despite the decrease to net assets from non-operating activities of $141.6 million, the University finished the year with $2.65 billion in total net assets. As we enter the next fiscal year, uncertainties in federal and state government budgets and the global economy will continue to challenge the institution. Strategic planning and careful program investments will be critical inputs to the University s future financial performance. Douglas W. Wylie University Controller 6

7 Report of Independent Auditors To the Board of Trustees University of Rochester In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of activities and of cash flows present fairly, in all material respects, the financial position of the University of Rochester (the University ) at June 30, 2012 and 2011, and the changes in their net assets and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the University s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1(i) to the consolidated financial statements, the University changed the manner in which it classifies accumulated total investment returns within net assets as a result of the adoption of ASC 958, Not-for-Profit Entities (formerly FASB Staff Position No ) at July 1, October 16,

8 University of Rochester Financial Statements Consolidated Financial Statements Consolidated Balance Sheet As of June 30 (dollars in thousands) Assets Cash and cash equivalents $ 326,227 $ 285,203 Operating investments, at market 209, ,393 Collateral held for securities lending - 69,282 Accounts receivable, net 325, ,169 Inventories, prepaid expenses, and deferred charges 52,816 48,957 Contributions receivable, net 90,927 51,556 Notes receivable, net 48,347 48,006 Other assets 11,936 15,536 Investments held for long-term purposes 1,822,954 1,783,356 Property, plant and equipment, net 1,561,957 1,453,775 Interest in net assets of foundation 12,330 13,743 Investments in perpetual trusts held by others 46,877 49,780 Total assets $ 4,509,160 $ 4,320,756 Liabilities Accounts payable and accrued expenses $ 388,337 $ 305,494 Advanced receipt of sponsored research revenues 23,472 25,618 Deferred revenue 50,775 52,069 Third-party settlements payable, net 100,989 96,386 Securities lending liabilities - 69,282 Accrued pension, post-retirement, and post-employment 386, ,073 Long-term debt 874, ,913 Asset retirement obligation 19,016 18,057 Refundable U.S. Government grants for student loans 16,223 16,004 Total liabilities 1,859,493 1,636,896 Net Assets Unrestricted 1,745,673 1,818,709 Temporarily Restricted 509, ,216 Permanently Restricted 394, ,935 Total net assets 2,649,667 2,683,860 See accompanying notes to consolidated financial statements. Total liabilities and net assets $ 4,509,160 $ 4,320,756 8

9 Consolidated Financial Statements Consolidated Statement of Activities Year Ended June 30, 2012 (dollars in thousands) Temporarily permanently Operating revenues unrestricted RestricteD Restricted Total Tuition and fees $ 360,695 $ - $ - $ 360,695 Less: scholarships and fellowships (151,430) - - (151,430) Net tuition and fees 209, ,265 State and local appropriations 1, ,851 Grants and contracts 396, ,145 Gifts and pledges 25,747 49,738 36, ,805 Hospital and faculty practice patient care activities 1,860, ,860,382 Auxiliary enterprises 88, ,728 Interest income and appreciation of operating investments 5, ,537 Educational activities 28, ,540 Royalty income 34, ,431 Other sources 14, ,252 Long-term investment income and gains allocated to operation 88, ,390 Net assets released from restrictions 53,701 (53,365) (336) - Total operating revenues 2,806,969 (3,627) 35,984 2,839,326 Operating expenses Salaries and wages 1,369, ,369,458 Fringe benefits 400, ,322 Total compensation 1,769, ,769,780 Supplies 350, ,767 Business and professional 190, ,815 Utilities 52, ,253 Maintenance and facilities costs 114, ,210 Depreciation 163, ,619 Interest 30, ,604 Other 59, ,881 Total operating expenses 2,731, ,731,929 Change in net assets from operating activities 75,040 (3,627) 35, ,397 Non-operating activities Long-term investment activities: Investment income 10,036 2,569 (113) 12,492 Net appreciation / (depreciation) (12,466) 5,888 (1,816) (8,394) Total long-term investment activities (2,430) 8,457 (1,929) 4,098 Long-term investment income and gains allocated for operations (88,390) - - (88,390) Loss on extinguishment of debt (636) - - (636) Other changes, net (56,620) 262 1,315 (55,043) Change in valuation of annuities - (1,775) 156 (1,619) Change in net assets from non-operating activities (148,076) 6,944 (458) (141,590) Change in net assets (73,036) 3,317 35,526 (34,193) Beginning net assets 1,818, , ,935 2,683,860 Ending net assets $ 1,745,673 $ 509,533 $ 394,461 $ 2,649,667 See accompanying notes to consolidated financial statements. 9

10 University of Rochester Financial Statements Consolidated Statement of Activities Year Ended June 30, 2011 (dollars in thousands) Temporarily permanently Operating revenues unrestricted RestricteD Restricted Total Tuition and fees $ 343,537 $ - $ - $343,537 Less: scholarships and fellowships (142,321) - - (142,321) Net tuition and fees 201, ,216 State and local appropriations 1, ,875 Grants and contracts 438, ,022 Gifts and pledges 19,618 17,781 24,455 61,854 Hospital and faculty practice patient care activities 1,783, ,783,587 Auxiliary enterprises 79, ,653 Interest income and appreciation of operating investments 13, ,538 Educational activities 29, ,894 Royalty income 42, ,318 Other sources 13,758 (28) - 13,730 Long-term investment income and gains allocated to operations 87, ,717 Net assets released from restriction 47,659 (47,659) - - Total operating revenues 2,758,855 (29,906) 24,455 2,753,404 Operating expenses Salaries and wages 1,306, ,306,985 Fringe benefits 367, ,618 Total compensation 1,674, ,674,603 Supplies 344, ,487 Business and professional 195, ,798 Utilities 53, ,918 Maintenance and facilities costs 112, ,914 Depreciation 158, ,441 Interest 29, ,344 Other 81, ,732 Total operating expenses 2,651, ,651,237 Change in net assets from operating activities 107,618 (29,906) 24, ,167 Non-operating activities Long-term investment activities: Investment income 12,775 4,611 (126) 17,260 Net appreciation 140, ,119 7, ,027 Total long-term investment activities 153, ,730 7, ,287 Long-term investment income and gains allocated for operations (87,717) - - (87,717) Other changes, net 7,909 (205) 3,157 10,861 Change in valuation of annuities - (2,753) (752) (3,505) Change in net assets from non-operating activities 73, ,772 9, ,926 Change in net assets before cumulative effect of change in accounting principle 181,220 86,866 34, ,093 Cumulative effect of change in accounting principle (239,778) 239, Change in net assets (58,558) 326,644 34, ,093 Beginning net assets 1 877, , , ,767 Ending net assets $ 1 818,709 $ 506,216 $ 358,935 $ 2 683,860 See accompanying notes to consolidated financial statements. 10

11 Consolidated Financial Statements Consolidated Statement of Cash Flows Years Ended June 30 (dollars in thousands) Cash flows from operating activities Change in net assets $ (34,193) $ 302,093 Adjustments to reconcile change in net assets to net cash provided by operating activities: Depreciation expense 163, ,441 Net depreciation / (appreciation) on long-term investment activities 8,394 (263,027) Gifts of property, plant, equipment, and other (307) (1,308) Bond discount amortization (1,294) (762) Loss on the extinguishment of debt Provision for bad debts 10,668 25,718 Contributed securities (13,452) (10,504) Loss on disposals of property, plant, and equipment 7,740 2,389 Contributions for long-term investments, net (33,235) (24,636) (Increases) / decreases in: Operating investments (746) (7,840) Accounts receivable, net (44,272) (10,054) Inventories, prepaid expenses, and deferred charges (3,338) 259 Contributions receivable, net (37,782) (5,376) Other assets 3,362 (2,788) Increases / (decreases) in: Accounts payable and accrued expenses 61,553 7,531 Advanced receipt of sponsored research revenues (2,146) 2,489 Deferred revenues (1,294) 562 Third-party settlements payable, net 4,603 3,819 Accrued pension, post-retirement, and post-employment 78,399 24,511 Net cash provided by operating activities 166, ,517 Cash flows from investing activities Purchases of property, plant, and equipment (268,986) (206,424) Purchases of investments (509,988) (621,295) Proceeds from the sale of investments 492, ,248 Increase in investments in perpetual trusts held by others (96) (95) (Increase) / decrease in notes receivable, net (341) 157 Net cash used in investing activities (287,246) (151,409) Cash flows from financing activities Net borrowings on lines-of-credit Principal repayments of long-term debt (42,652) (26,618) Proceeds from issuance of long-term debt 171,929 - Deferred financing costs (1,811) (1) Increase in refundable U.S. Government grants for student loans Contributions for long-term investments, net 33,235 24,636 Net cash provided by / (used in) financing activities 161,355 (1,149) Net increase in cash and cash equivalents 41,024 48,959 Cash and cash equivalents, beginning of year 285, ,244 Cash and cash equivalents, end of year $ 326,227 $ 285,203 Supplemental disclosure of cash flow information Cash paid during the year for interest on long-term debt $ 30,288 $ 28,740 Non-cash investing and financing activities: Increase in construction related payables $ 8,164 $ 4,407 Assets acquired under capital leases $ 248 $ 342 See accompanying notes to consolidated financial statements. 11

12 Notes to Consolidated Financial Statements (1) Summary of Significant Accounting Policies (a) General The University of Rochester (the University) is a private nonprofit institution of higher education based in Rochester, New York. The University provides education and training services, primarily for students at the undergraduate, graduate, and postdoctoral levels. It also performs research, training, and other services under grants, contracts, and similar agreements with sponsoring organizations, primarily departments and agencies of the United States Government; and provides health care services through Strong Memorial Hospital (Hospital), Strong Home Care Group, and the various entities included in Strong Partners Health System, Inc. (SPHS). 12 (b) Basis of Presentation The accompanying consolidated financial statements include all of the integrated divisions of the University Arts, Sciences & Engineering (including the Edmund A. Hajim School of Engineering and Applied Sciences and the School of Arts and Sciences), Margaret Warner Graduate School of Education and Human Development, William E. Simon Graduate School of Business Administration, Eastman School of Music, Memorial Art Gallery, School of Medicine and Dentistry, Strong Memorial Hospital, School of Nursing, Eastman Institute for Oral Health, Health Sciences, and the University of Rochester Medical Faculty Group (URMFG). Included also are Strong Partners Health System, Inc. (and its affiliates), Eastman Dental Center Foundation, Inc., Strong Home Care Group (and its subsidiaries), Crittenden Boulevard Housing Company, Inc., Excell Partners, Inc., Rochester BioVenture Center, Inc., High Tech Rochester, Inc., UR Investment, LLC, extensible Catalog Organization, LLC, University of Rochester Real Estate Corporation, UR Equity Holdings, Inc., the Meliora Real Estate Corporation, and Spruce Risk Purchasing Group, LLC. All significant interorganizational balances and transactions have been eliminated. The University is the sole member of SPHS, which is the sole member of Highland Hospital of Rochester (including its subsidiaries The Highland Foundation, Inc., Highland Facilities Development Corp., and the Medical Administrative Associates, Inc.); The Highlands Living Center, Inc.; Highland Community Development Corporation; and The Meadows at Westfall, Inc. Highland Hospital and its subsidiaries have debt outstanding, which has been included in the University s consolidated financial statements; however, under the terms of the affiliation agreement with SPHS, the University has no legal obligation for the debt of Highland Hospital and affiliates. The Eastman Dental Center Foundation, Inc. (the Foundation) was formed to hold and manage the investment assets of the former Eastman Dental Center, which was merged into the University during Income and assets of the Foundation are used to support oral health, education, and research projects at the University. The University is the sole corporate member of Strong Home Care Group, which is the sole member of Visiting Nurse Service of Rochester and Monroe County, Inc. and Community Care of Rochester. The University, through SPHS, Strong Memorial Hospital and URMFG, formed a Managed Care Organization (MCO) in October 1997 together with two community physician organizations: the Highland Physician Organization and the Rochester Community Physician Organization. The MCO has ceased operations related to member contracting activities and is in the process of finalizing its activities. The University is the sole corporate member of Crittenden Boulevard Housing Company, Inc., which was formed to provide affordable housing facilities for graduate students and staff of the University. The University is the sole corporate member of Excell Partners, Inc., which was formed to support early stage commercial development utilizing technologies created at the University of Rochester and other regional colleges and universities. The University is the sole corporate member of Rochester BioVenture Center, Inc., which was formed to support the development of new businesses utilizing technologies created at the University and other regional colleges and universities, through the operation of incubator/research facilities in Monroe County, New York. The University is the sole corporate member of High Tech Rochester, Inc. (HTR), which is a not-for-profit economic development organization that promotes the creation and growth of technology companies through support services and incubation facilities and provides consulting services for manufacturers. The University is the sole member of University of Rochester Investment, LLC, which was formed for the purpose of holding certain University investments.

13 Notes to Consolidated Financial Statements (Dollars in Thousands) The University is the sole member of extensible Catalog Organization, LLC, which was formed to support the charitable and educational activities of the University through development of open-source library catalog software. In December 2009, the University entered into a financing arrangement for the renovation of the Eastman Theatre enhanced by qualified investors in the New Markets Tax Credit (NMTC) program of the United States Treasury. The use of NMTCs is a program of the Community Development Financial Institutions Fund, a bureau of the United States Treasury. This transaction required the formation of a wholly owned special purpose corporation known as the University of Rochester Real Estate Corporation. In July 2010, UR Equity Holdings, Inc., a for-profit corporation, was formed for the purpose of holding the University s equity interests in startup companies. In May 2011, the University became the sole corporate member of Meliora Real Estate Corporation, which was formed to support the charitable activities of the University of Rochester by providing financial and operational support to the University through the acquisition, holding, and sale of real estate donated to the University and affiliates. The University is the sole member of Spruce Risk Purchasing Group, LLC, which was formed in October 2011 for the purpose of procuring insurance coverage for physicians and other health care providers affiliated with the University of Rochester Medical Center. (c) Basis of Accounting The consolidated financial statements of the University are prepared on the accrual basis of accounting and in conformity with generally accepted accounting principles in the United States of America. Classification of Net Assets: The University reports its net assets and changes therein according to three classifications: permanently restricted, temporarily restricted, and unrestricted, based upon the existence or absence of donor-imposed restrictions. Permanently restricted Net assets subject to donor-imposed stipulations that they be maintained permanently by the University. In accordance with the guidance provided in the New York Prudent Management of Institutional Funds Act (NYPMIFA), the University s Board of Trustees, with consideration of the actions, reports, information, advice, and counsel provided by its duly constituted committees and appointed officers of the University, has instructed the University to adopt a methodology designed to avoid spending below the historical dollar value of donor-restricted (true) endowment funds, absent explicit donor direction to the contrary. As a result, the University classifies as permanently restricted net assets the original gift value of true endowments plus any subsequent gifts and accumulations made in accordance with the directions of the applicable gift instruments. The portion of true endowment funds that is not classified as permanently restricted net assets is classified as temporarily restricted net assets in accordance with accounting standards. Temporarily restricted Net assets subject to donor-imposed stipulations that may or will be met either by actions of the University and/or the passage of time. Investment income and gains and losses on permanently restricted net assets are reported as temporarily restricted until appropriated for expenditure in accordance with donor-imposed stipulations. Under NYPMIFA, the appropriation and spending of such income is subject to a standard of prudence, as more fully discussed under the accounting policy note on investments, note 1(i). When a donor restriction expires, that is, when a stipulated time restriction ends or spending restriction is accomplished, temporarily restricted net assets are reclassified to unrestricted net assets and reported in the consolidated statement of activities as net assets released from restriction. Unrestricted Net assets that are not subject to donorimposed stipulations and that are generally available for support of the University s activities with certain limitations, as follows: Uses of certain unrestricted net assets are committed through contractual agreements. Such amounts primarily consist of required trusteed balances under long-term debt agreements and matching funds under student loan programs of the federal government. In addition, grants and contracts for the performances of certain services or functions are reported in the unrestricted net asset category. Many of the funds, which are unrestricted for accounting purposes, carry internal designations to specific divisions of the University, and therefore are not treated operationally as unrestricted funds. The Board of Trustees, through voluntary resolutions, has set aside portions of the University s unrestricted net assets to function as endowment, for property, plant, and equipment purposes, and for other specific operating purposes. Revenues from sources other than contributions are generally reported as increases in unrestricted net assets. Contributions are reported as increases in the appropriate category of net assets, except those contributions whose imposed restrictions are met in the same fiscal year they are received, are included in unrestricted revenues. Expenses are reported as decreases in unrestricted net assets. Expiration of temporary restrictions recognized on net assets (i.e., the donor-stipulated purpose has been fulfilled and/or the stipulated time period has elapsed) are reported as releases from temporarily restricted net assets to unrestricted net assets. Temporary restrictions on gifts to acquire long-lived assets are considered met in the period in which the assets are placed in service. 13

14 University of Rochester Financial Statements (d) Income Taxes The University and the majority of its affiliates are not-for-profit organizations as described in section 501(c)(3) of the Internal Revenue Code and are generally exempt from income taxes on related income pursuant to Section 501(a) of the Code. (e) Operations The statements of activities present the changes in net assets of the University from operating activities and from non-operating activities. Operating revenues and expenses relate primarily to educational and training programs, research activities, and hospital and patient care activities provided by the University and its related entities. Utilization of investment income and gains on long-term investments held for endowment and similar purposes under the University s total return spending policy, as discussed in note 1(i), is considered operating revenue. Non-operating activities consist primarily of investment income and appreciation from long-term investments in excess of amounts utilized for operations. Other changes, net consists primarily of adjustments in pension, post-retirement, and post-employment obligations based on actuarially determined liabilities. (f) Cash and Cash Equivalents and Operating Investments Cash and cash equivalents include amounts on deposit with financial institutions; short-term investments with maturities of three months or less at the time of purchase and other highly liquid investments, primarily cash management funds, except that such instruments purchased with endowment and annuity and life income assets on deposit with trustees are classified as investments. Operating investments include all other current investments with original maturities greater than three months and are used to support operations. These current investments include obligations of the U.S. Treasury, U.S. Government and other government agencies, and corporate and foreign bonds. Included also are internal operating funds invested in the University s longterm investment pool; however, they may be liquidated upon demand at any time. (g) Inventories Inventories, primarily medical supplies, are valued at the lower cost, which is determined by the first-in, first-out method, or market. (h) Contributions Contributions, including unconditional promises, or pledges, are recognized as revenues in the period received. Conditional promises to give are not recognized until the conditions on which they depend are substantially met. Contributions of assets other than cash are recorded at their estimated fair value at the date of the gift. Contributions to be received after one year are discounted, at a range of 2% to 4%, to their present value. Amortization of the discount is recorded as additional contribution revenue and used in accordance with donor-imposed restrictions, if any, on the contributions. Allowance is made for uncollectible contributions based upon management s judgment and analysis of the creditworthiness of the donors, past collection experience, and other relevant factors. (i) Investments and Spending Policy The University s investments comprise the assets of the University s endowment and other investments held for general operating purposes. The University reports those investments at fair value as described further in note 12. The Board of Trustees interprets NYPMIFA to allow for the spending of income and gains on investments of permanently restricted net assets in a manner that is prudent, considering such factors as the duration and preservation of the endowment fund, the purposes of the institution and the endowment fund, general economic conditions including the potential effect of inflation or deflation, the expected total return of the fund, other resources of the University, the needs of the University and the fund to make distributions and preserve capital, and the University s investment policy. Investment of the University s net assets held for endowment and similar purposes is based upon a total return policy, and the utilization of its endowment resources for current operating and capital needs is related to this policy. Although NYPMIFA does not preclude the University from spending below the original gift value of permanently restricted funds, the University s policy is to spend no more than a stated percentage of fair value of its investment portfolio over time. Accordingly, during fiscal year 2012, the Board of Trustees authorized the use of total return (income and appreciation) from its endowment resources at an aggregate rate of 5.9% (5.9% during fiscal year 2011) of the average fair value of its consolidated investment portfolio for the most recent five years. To the extent that the total return requirement for the current year is not fulfilled by interest and dividends, the University utilizes the appreciation of its endowment and similar net assets for operating purposes. To the extent that the total return requirement for the current year is exceeded by interest and dividends, the University reinvests the excess in its net assets held for endowment and similar purposes. The University, in compliance with NYPMIFA, notified available donors who had established endowments prior to September 17, 2010, of the new law, and offered these donors the option of requiring the University to maintain historical dollar value for their endowment funds. A minority of donors requested this option; for those who did, the University has designed procedures to ensure that the University maintains historical dollar value. 14

15 Notes to Consolidated Financial Statements (Dollars in Thousands) Investment securities are exposed to various risks, such as interest rates, market, economic conditions, world affairs, and credit risks. Due to the level of risk associated with certain investment securities, it is possible that changes in value could occur in the near term and such changes could materially affect the amounts reported in the investments and investment activity of the University. In prior years, the University participated in securities lending activities. All loans were callable at any time and were fully collateralized. Investments that were loaned to another institution were included in investments held for long-term purposes on the consolidated balance sheet. Cash received as collateral on the securities lending transactions was reported as collateral held for securities lending on the consolidated balance sheet. Since the collateral had to be returned in the future, a corresponding liability was reported on the consolidated balance sheet. During fiscal year 2012, the University decided to no longer participate in securities lending activities. (j) Property, Plant, and Equipment Property, plant, and equipment are stated at cost or at estimated fair value if acquired by gift, less accumulated depreciation and amortization. Buildings used for research activities are componentized as site improvements, buildings, building services, and fixed equipment. Depreciation of research building components is recorded using the straight-line method over the useful lives of the components ranging from 4 to 40 years. Depreciation of nonresearch buildings, equipment and library books, and amortization of leasehold and land improvements are computed using the straight-line method over the estimated useful lives of the assets. Land and museum collections are not subject to depreciation. Estimated useful lives for non-research assets are as follows: Years Building 40 Building and leasehold improvements 20 Land improvements 20 Equipment 4 to 15 Library books 10 The University reports gifts of property, plant, and equipment as unrestricted support unless explicit donor stipulations specify how the donated assets must be used. Gifts of long-lived assets with explicit restrictions that specify how the assets are to be used and gifts of cash or other assets that must be used to acquire long-lived assets are reported as temporarily restricted support. Absent explicit donor stipulations about how long those long-lived assets must be maintained, the University reports expirations of donor restrictions when the donated or acquired long-lived assets are placed in service. (k) Museum Collections The University capitalizes museum collections. If purchased, collection items are capitalized at cost and if donated, at their appraised or fair value on the accession date (the date on which the item is accepted by the Board of Trustees). There is no depreciation recorded on collection items. (l) Split Interest Agreements and Perpetual Trusts The University s split interest agreements with donors consist primarily of gift annuities, unitrusts, charitable remainder annuity trusts, and life income agreements. Assets held under these agreements are included in investments held for long-term purposes and investments in perpetual trusts held by others. For fiscal years 2012 and 2011, the fair values for split interest agreements are $78,750 and $81,119, respectively. Generally, contribution revenues are recognized at the dates the agreements are established and liabilities are recorded for the present value of the estimated future payments to be made to the beneficiaries. The liabilities are adjusted during the term of the trusts for changes in the value of the assets, accretion of the discount and other changes in the estimates of future benefits. The University is also the beneficiary of certain perpetual trusts held and administered by others. The present values of the estimated future cash receipts, which are measured by the fair value of the assets contributed to the trust, are recognized as assets and contribution revenues at the dates the trusts are established. The carrying value of the assets is adjusted for changes in the fair value of the trust assets for both split interest agreements and perpetual trusts. (m) Refundable U.S. Government Grants for Student Loans Funds provided by the United States Government under the Federal Perkins, Nursing, and Health Professions Student Loan programs are loaned to qualified students and may be re-loaned after cash collections. These funds are ultimately refundable to the government and are recognized as a liability in the accompanying consolidated balance sheet. (n) Grants and Contracts Revenue from grants and contracts, primarily for research and training programs, is generally recognized as earned, that is, as the related costs are incurred under the grant or contract agreements. Amounts received in advance are reported as advance receipt of sponsored research revenues. Grants and contracts awarded to the University are subject to audit by the various sponsoring agencies. Indirect costs recovered on grants and contracts are recorded at rates established by the University with the federal government, or predetermined by the non-federal sponsor. Indirect cost rates for government grants and contracts are subject to audit, and subsequent final settle- 15

16 University of Rochester Financial Statements ments are recorded as current period adjustments. Management believes the impact of any future settlements to be immaterial to the consolidated financial statements. (o) Benefit Plans The University provides certain health care and life insurance benefits to retired employees and spouses under a defined benefit plan. Benefits include basic medical and major medical coverage. Certain categories of retirees receive dental coverage and group life insurance. Such post-retirement benefits are accounted for as a form of deferred compensation over the estimated service lives of employees. Post-employment benefits include benefits provided to former or inactive employees after employment but before retirement. For the University, such benefits include workers compensation benefits, short-term disability benefits, and benefits provided under various other programs. (p) Hospital and Faculty Practice Patient Care Activities The Hospital has agreements with third-party payors that provide for payments to the Hospital at amounts different from its established rates. A summary of the payment arrangements with major third-party payors follows: Medicare Under the Medicare program, the Hospital receives reimbursement under a prospective payment system (PPS) for inpatient services. Under the Hospital inpatient PPS, fixed payment amounts per inpatient discharge are established based on the patient s assigned diagnosis related group (DRG). When the estimated cost of treatment for certain patients is higher than the average, providers typically will receive additional outlier payments. The Hospital also receives reimbursement under a prospective payment system for certain medical outpatient services, based on service groups, called ambulatory payment classifications (APCs). Other outpatient services are based upon a fee schedule and/or actual costs. The Hospital s Medicare cost reports are subject to audit by the fiscal intermediary. Such audits have been done through December 31, Medicaid and Other Third-Party Payors The New York Health Care Reform Act of 1996 (HCRA), as amended, governs payments to hospitals in New York State (NYS). Under HCRA, Medicaid, workers compensation, and nofault payors payment rates are promulgated by the New York State Department of Health (DOH). Fixed payment amounts per inpatient discharge are established based on the patient s assigned case mix intensity similar to a Medicare DRG. All other third-party payors, principally Blue Cross, other private insurance companies, Health Maintenance Organizations (HMOs), Preferred Provider Organizations (PPOs) and other managed care plans, negotiate payment rates directly with the hospitals. Such arrangements vary from DRG-based payment systems, to per diems, case rates, and percentage of billed charges. If such rates are not negotiated, then the payors are billed at the Hospital s established charges. Effective December 1, 2009, NYS implemented inpatient reimbursement reform. The reform updated the data utilized to calculate payment rates utilizing All Patient Refined DRGs (APR-DRGs). APR-DRGs used revised service intensity weights (SIWs) to adjust each APR-DRG for patient acuity. Similar type outpatient reforms were implemented effective December 1, 2008, by connecting outpatient payments to Ambulatory Payment Groups (APGs), which use outpatient SIWs based on types of service and resource consumption. In addition, under HCRA, all non-medicare payors are required to make surcharge payments for the subsidization of indigent care and other health care initiatives. The percentage amounts of the surcharge vary by payor and apply to a broader array of health care services. Also, certain payors are required to provide additional funds through surcharges on payments to hospitals for inpatient services or through voluntary election to pay a covered lives assessment directly to the DOH. Revenue from Blue Cross and Preferred Care accounted for approximately 28% and 6%, respectively, of the Hospital s net patient service revenue for the year ended June 30, 2012, and 27% and 7%, respectively, for the year ended June 30, Revenue from Medicare and Medicaid programs accounted for approximately 32% and 18%, respectively, of the Hospital s net patient revenue for the fiscal year ended June 30, 2012, and 32% and 17%, respectively, for the year ended June 30, Laws and regulation governing the Medicare and Medicaid programs are extremely complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates will change by material amounts in the near term. The Hospital believes that it is in compliance, in all material respects, with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. Compliance with such laws and regulations can be subject to future government review and interpretation. Non-compliance with such laws and regulations could result in repayments of amounts improperly reimbursed, substantial 16

17 Notes to Consolidated Financial Statements (Dollars in Thousands) monetary fines, civil and criminal penalties, and exclusion from the Medicare and Medicaid programs. Both federal and New York State regulations provide for certain adjustments to current and prior years payment rates and indigent care pool distributions based on industry-wide and hospital-specific data. The Hospital has established estimates based on information presently available of the amounts due to or from Medicare, Medicaid, workers compensation, and no-fault payors and amounts due from the indigent care pool for such adjustments. Those adjustments, which can be reasonably estimated, have been provided for in the accompanying financial statements. The Hospital has estimated the potential impact of such adjustments based on the most recent information available. However, those which are either (a) without current specific regulations to implement such adjustments, or (b) are dependent upon certain future events and cannot be reasonably estimated have not been provided for in the accompanying financial statements. Management believes the amounts recorded in the accompanying financial statements will not be materially affected upon the implementation of such adjustments. During fiscal years 2012 and 2011, the Hospital recognized approximately $19,300 and $17,300 of net patient service revenue as a result of changes in estimates related to third-party settlements. In addition, the Hospital recognized additional third-party payables of approximately $17,800 and $16,000 related to fiscal years 2012 and 2011, respectively. There are various other proposals at the federal and NYS levels relating to Medicare and Medicaid, that could, among other things, reduce reimbursement rates, modify reimbursement methods, or increase managed care penetration. The ultimate outcome of these proposals and other market changes cannot presently be determined. The URMFG is an operating division of the University. In the year ending June 30, 2012, over 1,111 full-time faculty in 18 clinical departments and two clinical centers participated in patient care at the University of Rochester Medical Center. These full-time faculty physicians handled 871,333 outpatient visits in their offices, mostly on University-owned or leased premises; and covered 35,802 hospital admissions, as well as participated in the coverage of the emergency department handling over 99,523 visits. Payments for these services are derived primarily from thirdparty insurers including Managed Care companies (19.67%), Medicare (21.93%), Blue Shield (24.20%), Medicaid (10.59%), commercial (9.03%), other (5.25%), and self-pay (9.33%). In addition to providing clinical outpatient care, the faculty group s mission is met by providing education and teaching. The faculty supervise and instruct 436 University medical students and 782 residents and fellows. (q) Charity Care and Provision for Bad Debts As further described in note 17, the University provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the Hospital does not pursue collection of amounts determined to qualify as charity care, these are not reported as revenue or patient accounts receivable. The University grants credit without collateral to patients, most of whom are local residents and are insured under thirdparty arrangements. Additions to the allowance for uncollectible accounts are made by means of the provision for bad debts. Accounts written off as uncollectible are deducted from the allowance and subsequent recoveries are added. The amount of the provision for bad debts is based upon management s assessment of historical and expected net collections, business and economic conditions, trends in Federal and State governmental health care coverage and other collection indicators. (r) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses during the reporting period. Management s assumptions are primarily related to the appropriate discount rate for the purposes of fair value calculations, allowances for doubtful accounts, self-insured risks, and third-party payor contractual adjustments and allowances. Actual results may differ from those estimates. (s) Investment in Net Assets of Foundation The University accounts for its interest in the net assets of the James P. Wilmot Foundation, Inc. (Foundation) in accordance with not-for-profit guidance. The guidance establishes standards for transactions in which a donor transfers assets to a not-forprofit organization or charitable trust, which then agrees to transfer those assets, the return on investment of those assets, or both to a beneficiary specified by the donor. Under the accounting guidance, the University is required to recognize the net assets and its share of the change in the net assets of the Foundation. The Foundation was established for the support of cancer research at the University s School of Medicine and Dentistry. (t) Asset Retirement Obligations The University accounts for asset retirement obligations in accordance with asset retirement and environmental obligations guidance. This guidance primarily affects the way the University accounts for asbestos-related removal costs. The University accrues for asset retirement obligations in the period incurred if sufficient information is available to reasonably estimate the fair 17